Buybacks at Small Banks Mean Big Profits Ahead

by Tim Melvin | February 6, 2014 3:09 pm

Buybacks at Small Banks Mean Big Profits Ahead

I am an enormous fan of the small banks. The economic and regulatory trends faced by these banks are going to force a lot of smaller institutions around the country to put themselves on the auction block and sell to a larger institution. Those that survive as a standalone bank will have proved their ability to take on the larger banks head-to-head and earn higher returns for their shareholders by stealing business from the too-big-to-fail banks like Bank of America (BAC[1]), Wells Fargo (WFC[2]) and Citigroup (C[3]).

Put simply, investing in smaller banks with decent balance sheets and loan portfolios seems to be as close to a win-win situation as you’ll ever find in the stock market.

I try to find those banks where management is using their excess capital to buy back stock at favorable prices. While I’m not a fan of buybacks done at high multiples of earnings and asset value — as we have seen in many larger companies in the past few years — when buybacks are done at low prices, shareholders should reap substantial benefits from increased ownership in the bank. Stock buybacks below book value that actually reduce the share count and don’t just hide excessive option and stock grant compensation can be a strong catalyst for increased shareholder value … and higher stock prices.

In the aftermath of the credit and banking crisis, many banks stopped returning cash to shareholders via buybacks or dividends. Capital was needed to offset the flood of bad loans and other nonperforming assets. Now the credit picture is improving rapidly and we are starting to see some of the little banks begin to buy back shares in the open market once again.

Westfield Financial (WFD[4]) has 11 branches and about $1.3 billion in total assets in Massachusetts. The company has been consistently buying back its shares and in September authorized another 5% stock buyback plan. In the fourth quarter alone the bank repurchased 603,046 shares of its stock at below book value. In addition to the buyback, the bank pays a generous dividend — 3.22% at the current price.

ASB Bancorp (ASBB[5]) is the holding company for Ashville in western North Carolina. The bank has 13 branches and total assets of around $733 million. Nonperforming assets are just 2.1% of total assets and the bank is massively over-reserved for future losses, with loan reserves at 6 times nonperforming loans. The bank bought back 544,494 shares of common stock at an average price of $16.79 per share in 2013. The board just authorized a new 5% buyback in January 2014. The stock is trading around 80% of book value, so management is buying the shares on the cheap — and that should bode well for shareholders in the future.

Small banks are one of the most attractive sectors for investors right now. I expect these little banks will be huge winners over the next several years … and banks that are buying back their stock below asset value should see much higher stock price over the next three to five years.